Commodities Market Vibrations

Futures Market Vibrations

Each market has its own personality. The action in the gold market can be completely different from the action of the silver market, though they’re both precious metals. The same holds true for the corn market versus the wheat or soybean markets. Each market must be considered separately; remember that it’s unwise to be influenced by the action of a related commodity. True, if the soybean market is building into a bull market, the rest of the grain complex may follow sympathetically, but not usually to the same degree.

The fundamentals of two related commodities may be completely different, though if they’re extremely bullish for one grain commodity, that will reflect on the others. If, for example, the price of corn gets too high and the price of wheat stays low, the livestock feeder will substitute the cheaper of the two for feed, which will even out the spread.

It’s no different for financial instruments. If bond yields continue to work higher, the stock market will inch lower. If I can receive a better return on my investment in the bond market, I would naturally be inclined to sell my stock portfolio and purchase bonds. When the stock market is going through massive selling, the bond market will rally due to a “flight to quality” by money managers.

When looking at patterns of commodities, we can see that certain markets have different cyclical low-timing patterns and that all commodities do not follow a strict cycle pattern. A good example of how we should respect the “personality” of each commodity is to look at feeder cattle vs. live cattle. You might think they would cycle similarly, but they don’t. Live cattle futures bottom every 15 days, yet the feeder cattle contract tends to bottom every 18 days.

The individuality of each market is apparent when we study the chart patterns. Taking soybeans as an example, the price of beans may change three percent, while the price of bean meal may vary only one percent. Even though the two are related, their fundamentals are different. There have been times in my career where I made a successful forecast, but was struck out of the game when I traded the wrong sector.

Metals Markets

Gold

This is my favorite commodity, because it cycles the best. The gold market strictly adheres to the recurrence of a bottom every 16 days. It follows the quadrants of four days up, then four days down into the mid-cycle low, followed by four days up and then four down into the next intermediate-cycle low. This cyclical pattern remains true on weekly charts, so it is important to follow the weekly chart very closely when trading in gold futures.

In the old days, gold was traded somewhere in the world at almost all hours of the day and night, consequently it had the tendency to have gap openings when the market opened in the United States. Now, the U.S. exchanges have two methods for trading many markets: the “pit”, with the open outcry as in an auction, and the electronic market where the trades are established from the “bid” and “ask”. With the advent of electronic trading, the U.S. gold market is open 21 hours a day. The market stimuli for gold are economic news, inflation indicators, currency valuations, wars, embargoes, and the pivotal Middle East. There are a host of things that affect its price fluctuations, and gold is a barometer of world stability. When it’s “up”, the world is usually in some sort of chaos, and when it’s “down” (or steady), usually things are more stable.

The U.S. contract traded on the exchange is 100 troy ounces. The valuation of a $1 price move in gold is $100. On average, gold will have at least a $3 trading range every day and every now and then, the market will have a $10 swing from high to low. It’s to your advantage to place your stop-loss orders outside of a $3 trading range, once the market has established the opening range of prices for the day.

Silver

As you will note, silver is not listed as one of the commodities with a dominant cycle from low to low. I have not found a cyclical pattern that is consistent in this market. Deemed the “poor man’s gold,” it is influenced by the price of gold. In recent years, silver has become more of an industrial metal than a precious metal. The components of computers require silver, so the explosion in computer technology has created a greater demand for this commodity.

Silver is a by-product of gold, copper and other mining operations. As mining companies sort through the ore and extract the metals they are seeking, they also extract the silver. Therefore, when the demand for another metal is high, the supply of silver will increase, creating a climate for an oversupply. There are very few pure silver mines in the world, because the price of silver remained below the cost of production for 20 years.

The primary use for silver as a commodity is coinage. Recently, the United States government minted “Silver Rounds”, coins that are nearly 100 percent silver. These coins are not meant to replace the regular coinage for purchasing goods or services, but are for collectors or investors.

Like gold, silver is traded 21 hours a day in the States and 24 hours a day in the world. The contract size traded on the U.S. exchange is 5000 ounces and has a typical daily trading range of $0.15 an ounce. A “big day” range might be $0.50 per ounce, and the market in recent years has only had a range of $1 from year to year. The 30-year low has now been set in this market, so look for it to begin moving higher into the coming years. The fundamentals are becoming increasingly bullish as each year passes.

Platinum and Palladium

Platinum is considered a rare commodity, with Russia holding 95 percent of the world’s known reserves. Because they can control the price structure by governing the amount they produce, it is difficult for a true fundamentalist to predict prices. In the past seven years, platinum has primarily been used for the production of catalytic converters in automobiles and also for jewelry. Recently, the Japanese have created new technology for catalytic converters that eliminates the need for platinum and palladium.

Technically, this market does not chart well and is too thin for my taste (too little volume along with high volatility). The erratic activity of this market makes a disciplined trading strategy difficult to carry out. The market generally gaps open because of the lack of liquidity and few market participants. Until it develops more open interest, I don’t recommend trading it.

The contract size of platinum is 50 ounces, with an average daily range of $15. A $1 price change is a net gain or loss of $50. Platinum is a commodity that will have big days with swings of $20 and it can easily advance or decline $200 per year. Once this market has developed a trend, it will tend to stay there for long periods of time and have huge price advances or declines. The platinum market is dominated by commercial interests and lacks speculator influences, which makes it difficult for a trader to compete.

Palladium, just as with platinum, is also primarily a product of Russia, and the fundamentals are difficult to predict. The majority of palladium has been used for the production of catalytic converters. This market has big ranges throughout the year and lacks real liquidity.

Technically, there is not a pronounced cyclic pattern or seasonality here; it’s a market driven by supply and demand and dominated by commercials. Palladium does not trend well and lacks investor participation, therefore I favor investing in gold and silver instead.

Copper

Copper is not considered a true precious metal, but at times has been purchased as a “store of value” during a currency crisis. Copper is now considered an industrial metal; its market driven mostly by supply and world economics.

I like to follow the copper market closely for leadership signals in precious metal prices. When this market begins to move either way, the other metals will shortly be ushered in behind it. As we move into the final stages of hyperinflation, the global economies will begin to slow and so will advances in copper prices.
The copper futures contracts listed on the U.S. exchange are 25,000 pounds; each $0.01 move in copper is worth $250. This commodity has the tendency to cycle very well, yet has a problem with liquidity. As long as the trader is aware of that, copper can provide a trading opportunity. I seldom trade copper, but I do use it as a barometer for my gold trading.

Currencies

Following the demise of the gold standard in 1933, foreign currencies were free to fluctuate. It is believed that the sharp fluctuations in currencies are caused by the balance of payments, the net inflow or outflow of a nation’s total currency transactions with other countries. These transactions alter the supply and demand for a specific currency.

The balance of trade measures the difference between exports and imports. If a country has a continuing trade deficit with other countries, it is said to be operating inefficiently. An example is the United States, whose balance of trade has been in deficit for the past 20 years. This situation can become critical, because it causes a slowdown in the economy and eventual currency devaluation.

Another component of the balance of payments is the capital flow, which measures the movement of money for investment purposes. So far, investment capital has offset the imbalance of trade the U.S. has maintained for the past 20 years. Other key indicators are interest rates, inflation, and political actions. If a country has higher interest rates, the flow of its investment capital will keep the currency valuation higher.

Inflation is considered to be one of the major concerns in the valuation of a country’s currency. We should note that when gold prices rise, foreign currencies will parallel the price movement. Gold is driven more by economic instability and inflationary fears than by supply and demand.

When trading foreign currency futures, we see that all currencies have responded to the increase or decrease of the dollar. In general, if one currency rallied against the dollar, the other currencies would follow suit. The Canadian dollar has been an exception to that tendency. Though closely related to the American dollar, the Canadian dollar seems to respond to its own economics.

Foreign currencies do not have a dominant short term cycle, however I have discovered there has been a recurrence of lows develop every nine weeks. Currency markets trend well once they have established a direction. Like the metals markets in the days before electronic trading and expanded hours, the currencies had big gaps between their closing time and the time our domestic markets opened. Not anymore. Remember that while we are heading home from work, having our dinner or are fast asleep at night, dramatic price changes may be taking place before the opening bell tomorrow.

Due to the size (monetary value) of the contracts traded on the International Monetary Market (IMM), currency trading is better suited to the seasoned trader. Political actions by world governments drive the value of currencies. At times, these actions may seem to be inconsistent and illogical and more often than not, they come suddenly, with little or no warning.

Interest Rates

Treasury bonds are 30-year bonds yielding six percent interest, and are the King of the financial pits. The contract size is $100,000 and trades in fractions of 1/32. Each tick has a value of $31.25. The T-bond market has great liquidity and enormous open interest, and is traded in the pit six and a half hours per day. This market is also traded electronically for almost 21 hours a day.

T-bonds respond to many economic indicators, including the actions of the Federal Reserve. Nearly every day of the week, the Treasury bond market is reacting to facts about inflation/deflation, unemployment, money supplies, consumer confidence, stock market fluctuations, currency valuations and more. Each day, this market is receiving fundamental information that affects the trader’s view of the price direction. That fact makes this market a great day-trading vehicle.

Technically, T-bonds chart very well and create a lot of opportunity for the trader. T-bonds adhere to the dominant 20-day cycle, so we can use time and price calculations for entering and exiting the market. This market has well-defined Elliot patterns that are easily recognizable. Since there is extreme volatility in this market, it doesn’t spend a lot of time in congestive areas.

Other markets in this category include two-year, five-year, and ten-year T-notes and 90-day T-bills. The other maturities will trade in tandem to the 30-year bonds and are primarily designed for institutional traders. I prefer to trade the 30-year T-bond, because of my familiarity with it and because it offers the most liquidity.

Indices

This group consists of indexes on nearly anything you can imagine…stocks, energies, metals, commodities, to name a few. The S&P (Standard & Poor’s) Stock Index is one of the more popular. Its economic function is to offer an investor the opportunity to hedge a stock portfolio as well as to speculate in any change in valuation. Of all the indices traded, the S&P has the largest market with the most open interest. The minimum tick is .025, which is worth $12.50 and normally has a daily range of at least ten points, or $1,250. The margin requirement to trade this market is substantial, and a mini-contract (which is one-fifth of the size), might be advisable for beginners.

Another popular index is the Dow Jones Industrial Average. It’s very active and I like to trade it because I can relate to this market and feel the activity better than the S&P Index. The volatility of the DJIA is less and the chart patterns are more definite. These indices have a dominant cycle of 20 days, like T-bonds, but do not chart as well. The minimum tick on the DJIA is one point, with a valuation of $10. There is also the mini-Dow which is half the size; one point is valued at $5.

Let’s consider the other futures contracts on indices similar to the S&P and the Dow futures currently traded on the exchanges. These markets are affected by the same economic indicators that affect T-bond futures. Generally speaking, indicators that are positive for bonds are positive for stocks as well. The two will trade in parallel except during stock market collapses, when the bond market will move in the opposite direction in a “flight to quality”.

Recalling that the function of the Federal Reserve is to control money supply and set interest rates in order to manage the economy: their objective is to prevent the economies of the world from having excessive booms and “bubbles”. Most of the time, this is successful, however when political agendas dominate management of economies, excesses will occur that can create devastating recessions. It happened following the stock market bubble of the 1990s and again during the real estate bubble earlier in this decade. In the past, an excessive stock market bubble has been followed by a bear market with an average length of 12 years.

Energies

This sector of the market is comprised of crude oil, heating oil, unleaded gas, natural gas, and electricity futures. Crude oil dominates most of the trading in energy futures and is a good place on which to focus trading. Heating oil is a very seasonal commodity that experiences a lot of attention from market participants. The natural gas contract is a big one and requires a high amount of capital to trade. It’s traded by many speculators, partly because it’s fun to trade. If you decide to trade natural gas, I suggest that you begin with the mini-contract, because it doesn’t usually result in the large equity draw-downs that the big contract does.

The rest of the energy markets are influenced by commercial interests and lack speculative trade. Again, fewer smaller investors in these markets results in a non-liquid market that is difficult to trade.
Energy futures have big range days and consequently a higher margin requirement than other commodities. The initial margin requirement ranges can be from 10 to 15 percent, compared to other commodities with three and four percent margins.

Due to the big range days and market volatility, energy commodities do not produce the quality of chart patterns that other commodities do. They don’t cycle well, nor do they allow good risk management. Speculation in energy futures requires a greater degree of attention to fundamentals; monitoring the constant changes in world politics is critical and time consuming.

Grains and Oilseeds

Grain commodities are stored on farms and in farm elevators or terminal-exporting facilities. Every futures contract has the economic reality of fulfilling the legal contract to deliver a commodity. This is where the true function of the market is represented. During the delivery month, many grain contracts are delivered to the holders of long futures positions and the making and taking of delivery occurs.

During the process leading up to delivery, the price will generally fall as the longs are liquidating their positions. Therefore, it’s to our advantage to watch for this phenomenon and start liquidating ahead of the crowd. Quite often, the low in the price structure shows up on the day before “first notice” of a delivery month.

Wheat

There are several varieties of wheat traded on three exchanges. Soft-red winter wheat is traded at the Chicago Board of Trade; hard-red winter wheat is traded on the Kansas City Board of Trade; hard-red spring wheat is traded on the Minneapolis Grain Exchange. The prices quoted for each type of wheat are different, because each has different milling qualities and its own set of fundamentals.

Wheat is produced for export as well as for domestic consumption, so it is heavily influenced by commercial interests. The Chicago Board of Trade is the largest exchange of the three with the greatest number of players. This makes it just as good an arena for the new trader as for the seasoned veteran.

Wheat markets are characterized by big volume and open interest, thus creating great liquidity. The wheat market differs from other grains and oilseeds in that it does not follow a dominant cycle very well. When charting, I have noticed that the 25-day cycle has occurred more often than any other timing cycle, but I start looking for reversals to occur on day 22. Another characteristic of wheat is that it makes V-shaped bottoms and tops rather than congestive and saucer types.

The fundamentals that affect this market are the weekly export figures reported on Thursday mornings. Every month, the United States Department of Agriculture reports supply/demand figures along with crop production figures. These statistical influences create trends in the markets.

The contract size (of all grains) traded on the exchanges is 5000 bushels, with a minimum tick of a quarter-cent per bushel, yielding $12.50 per tick. A $0.01 move in the grain commodities is worth $50.00. The margin requirements for grain commodities are generally three to five percent of the contract valuation.

Corn

Corn futures are traded on the CBOT and like wheat, corn is one of the major commodities exported to other countries in the world. Years ago, corn was used primarily for livestock feed and exporting, but in recent years, ethanol production has become a major end-user. American farmers produce most of the world’s supply of corn. We are seeing increased competition each year however, from China and South America.

The 20-day dominant cycle is well established in the corn market. The five-day quadrants come into play, thanks to weekly export numbers reported by the USDA. Corn also charts well, having good volume and open interest. It is heavily traded by speculators, and has a tendency to make congestive bottoms. This becomes very boring during bottom basing, but it can break out of congestion when we least expect it to happen.

So far, the influence of South American production has not affected the seasonality of this market. However, we need to be alert to future developments in South America (such as ethanol production), and how these factors may change things. China’s crop seasonality is similar to ours, due to their location in the Northern Hemisphere, and their production is increasingly affecting world exports and the U.S. position of dominance.

Soybeans

Soybeans and their by-products are traded only on the CBOT. The soybean in its raw form has limited use, but the crushing process creates two products: soybean oil and soybean meal. Soybean meal has high protein content, so its primary end-user is the livestock industry, with soybean oil reserved for human consumption.

In recent years, South America has developed soybean production to the point where they are jockeying for position as the number one producer in the world. This is changing the seasonality of the U.S. soybean market and may change the amount of production in the Northern Hemisphere.

Soybean futures produce nice, workable charts and cycle satisfactorily around the 20-day period. Soybeans and bean meal experience big range days. This is not due to a lack of liquidity, but to the number of players in the market.

The bean oil market does not experience the volatility of soybeans and bean meal, having smaller range days similar to the corn market. Therefore, the initial margin for soybean oil is smaller in contrast to beans and meal. A new trader may consider trading the soybean oil market prior to trading soybeans.

Livestock

Live Cattle

Live cattle futures are the star of the livestock pits and receive the most attention. The live (or fat cattle) futures contract is 40,000 pounds, and the minimum tick is $.0025, which relates to $10.00 per tick. The contracts are delivered to various points primarily located in the heartland of America. Hedgers play a major role in the price structure of the contracts.

The numbers of “cattle on feed” in feedlots across the U.S. and Canada are the major fundamental factor that dictates the price. Weather, slaughter numbers, and feed supplies are other contributing fundamentals. Adverse weather in the feedlots will result in zero or low weight gain of the cattle, resulting in a shortage of supply. High-priced grain will force cattle feeders to sell before they reach optimum weights, which also creates a shortage of supply.

The seasonality of cattle futures is about the same every year. The highest prices paid for cattle are in the first quarter of the year and the lowest prices are generally in July and August. The reason for this is supply-side economics; the shortest supply is in the first quarter of the year and the largest is during the summer months.

Cattle futures have the shortest cycle of any commodity. The dominant short-term cycle is 15 days and adheres very strictly to that. Importantly, this market produces textbook Elliot Wave patterns. I must mention the “big cycle”, which is 10 years in length; five years of trending up and five years of trending down. This is a classic, fascinating sun-spot cycle and has repeated itself for over 100 years. The market almost always bottoms on a year that ends in six and peaks on a year that ends in one; the same as the sun-spot cycle.

Feeder Cattle

Feeder cattle are placed into feedlots and fed a ration of grain and roughage in order to fashion them into live cattle, or “fats.” The contract size is 50,000 pounds, with a minimum tick of .0025, or $12.50 per tick. There is no delivery procedure, but rather a cash settlement when the contract reaches the last trading day. The cash settlement price is calculated by using an average cash price paid for feeder cattle at various set locations throughout the United States.

The fundamentals that affect feeder cattle futures are similar to those which affect the live cattle contract. Feed grain supplies and their price will have a major influence on the prices paid for feeder cattle. What is paid for the finished product (live cattle) is also a major determinant of the price paid for feeder cattle. The seasonality is similar to live cattle futures because of what is paid for the finished product.

The short-term cycle of 18 days is dominant and very consistent, even though this market is so closely related to live cattle futures, which has a short-term cycle of 15 days. The major long-term cycle of 10 years is the same for feeder cattle as it is for live cattle. This market does not exhibit as much open interest and volume as the live cattle futures contract, and the small speculator is largely absent. That accounts for price ranges that are bigger and more irregular.

Lean Hogs

The lean hog futures contract is 40,000 pounds of hog carcasses ready to be processed into pork products. The delivery process is the same as for feeder cattle; there is a cash settlement price paid rather than actual delivery of pork. The minimum tick is $.0025, or $10.00 per tick with a maximum $0.03 cent limit move.

The fundamentals are similar to live cattle futures and are represented by the numbers of hogs farrowed, as well as the age categories of the existing numbers. These statistics are calculated and reported via the monthly Hog and Pig Report by the USDA. The prices of feed grains will also affect the supply of hogs available to the market. Of course, the simple supply and demand of market-ready hogs will influence prices.

Hog futures follow a fairly strict 21-day cycle from low to low, but the market will exhibit some irrational activity in the process. It seems that this market is greatly influenced by commercial traders and “insiders”, so I avoid trading it.

Softs

Coffee, Cocoa, Sugar, Cotton, Orange Juice

These markets are all traded on various exchanges in New York and are high-risk, high-dollar commodities that trade very erratically. I generally avoid these markets, because they don’t chart well and have big gap openings from the prior day’s closing.

A trader can make big money trading these markets if he’s lucky enough to get on board when a major move develops. That’s why, when Hollywood makes a movie about a down-and-out hero who makes a killing in commodities, they have him make his fictional money trading orange juice futures.

These markets require high margins, owing to liquidity problems and the large ranges demonstrated from day to day. The option premiums are very steep also, so even trading them through options is an uncertain, tough process. These markets will spend long periods of time (perhaps years), in congestion before mounting a bull market. Once they reach full retail, they will fall dramatically, creating a great short sale.

The fundamentals for these markets are unreliable because the commodities are primarily from Third-world countries where slave labor still exists. Commercials dominate, so the small speculator really doesn’t stand much of a chance. Sugar and orange juice probably represent the best opportunities for the small speculator who insists on trading them, despite the odds.

The coffee futures market is fun to trade. If a trader has the financial resources and some skill and experience, he can enjoy his involvement in this market. There are pitfalls, so be prepared to trade with wide stops. This market loves to look for stop-loss orders. I haven’t seen good trends in the time frame from January to June.

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